Emerging Markets, Private Equity and Investing - Class 7

Emerging Markets

As the US real estate market continues to struggle, there are a variety of emerging markets that are catching the eyes of investors. The tops markets ripe for real estate investment are Brazil, China, India, Vietnam and Mexico. These markets share many factors in common that position them to be fit for investment while at the same time provide certain challenges.

These common themes are a growing middle class, increased housing demand, government subsidies for low income mortgages, increased demand for consumer products, and a low labor cost. The challenges are quite predictable when dealing with an emerging country. They include higher risk, political unrest, lack of liquidity, limited access to capital, a lack of corporate transparency, and rising inflation and cost of living. However, there are benefits to the investor which include a potential for higher return, portfolio diversification, and access to raw materials and cheap labor.

The most important factor in emerging markets is the explosion of the middle class. This rise is what drives demand for housing and consumer products. For example, Brazil’s middle class had an estimated 35 million people join between 2033 and 2009, and an additional 20 million are expected to be included by 2014, according to CNBC. Furthermore, Brazil’s unemployment is relatively low at 6.5 percent. This growth means nothing but dollar signs for the real estate market and economy as a whole.

Also, Brazil is gearing up for the 2014 World Cup and 2016 Olympics. These international sporting events will spur growth mainly in infrastructure but also the retail sector. Investors are knocking down the door trying to position themselves for the upcoming games.

Private Equity

As the real estate market regains steam in the United States, private equity funds may be left in the dust. Real Estate Investment Trusts (REIT’s) are positioned to act fast when an opportunity presents itself simply because they have access to large amounts of cheap capital. However, private equity funds face certain challenges.

First being the high cost of entry. These funds are largely seen as an expensive way to access the real estate class. For example, fees and expenses for Opportunistic Funds, the most risky, average 226 basis points (2.26%) while core Funds, the least risky, average 107 basis points (1.07%) for entry. Compared to typically entry via a REIT where expense ratios can be as low as 13 basis points (0.13%), or lower.

Secondly, the lengthy lag time to acquire private equity funds. As private equity fund managers spend their valuable time acquiring the necessary capital to purchase assets, the opportunity may already be missed or even purchased by another fund.

This is generally good news for REIT investors since they have a leg up. Private equity funds will continue to face these challenges going forward as investors are wary if investing in these funds.

Investing

Apartments are the hot investment class among investors at the moment. 2010 showed record growth in the multifamily sector as American’s, scared of the housing market, elected to rent instead of buy. Renters enjoy the benefits such as not being locked into a 30 year mortgage, paying no maintenance expenses, no longer need to spend hours repairing items, and greater flexibility in terms of size and location.

The multi-family market is responding with rising rents, fewer rental concessions, and new communities. Investors are paying top dollar for existence communities in major gateway cities as well as sites poised for strong growth. Lenders are also loosening their purse straps for ground-up projects in core markets as a response to sound fundamentals and strong interest from investors.

Axiometrics Inc., a provider of data and analysis on the multi-family housing sector, estimates that effective rents will rise 5.9% in 2011, which would be the largest annual increase since a rate of 5.8% in 2005. The top performing major markets for annual effective rent growth in May included San Jose (13.0%), San Francisco (9.7%), Austin (8.7%), Seattle (8.5%), Boston (7.4%), and Dallas (6.5%). Axiometrics predicts effective rents will continue to rise throughout 2011.

However, owners and investors preparing to enter the market in the near future may be too late to the party as the return on investment may prove to be less than those in the market in late 2009 and 2010. As large sums of money are entering the market, acquisitions prices are soaring. Capitalization rates are progressing south of 6.00% for core markets.

The question remains though, how long will the multi-family market continue to heat up and will the market become overpriced and over saturated? Furthermore, will consumers, who are used to large houses, prefer the simplicity of apartment living? The answer to that question will remain to be seen.